VC Past and Present: Towards Democratization

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Indexes
  1. The Origins of Investing
  2. The Origins of VC
  3. The Modern Age
  4. II. Towards Democratization
  5. Change on Many Fronts
  6. Technology-Enabled Change
  7. Conclusion

Recent writing for VDK Capital

I. A History

The Origins of Investing

Investing is almost as old as currency itself.

Ancient cuneiform tablet displaying economic transactions
Ancient cuneiform figure

Inscribed in ancient cuneiform, contracts written by members of the Mesopotamian elite evidence some of the earliest investing of humankind. These contracts dating to 2000 B.C. describe diverse economic agreements — from borrowing money against an anticipated harvest, to partnerships between those with capital (“investors”) and those who agree to contribute their time (“employees”) to a joint company.

In the 17th century, the Dutch East India Company constructed the Amsterdam Stock Exchange to issue shares for their corporation. For the first time in recorded history, citizens without explicit connection to a firm could invest in the enterprise’s success by becoming shareholders.

Now, a mere four centuries later, anyone with an internet connection can open their bank account app, their mobile payment app, or just about any financial services platform and be offered an investment entry position from one dollar to one million in publicly traded stocks, mutual funds, and cryptocurrencies. But private markets, and venture capital specifically, have lagged behind these trends of democratizing accessibility for public offerings.

Until very recently, VC remained mostly closed off to the average investor. Wealthy families, angel investors, and otherwise well-connected individuals possessed nearly exclusive access to these private market investments. But this is changing.

Before assessing this change in motion, though, let’s consider the comparatively short history of venture capital.

The Origins of VC

In his book, VC: An American History, Harvard Business School Professor Tom Nicholas discusses how high-risk, high-reward economic behaviors go back as far as whaling does — 4,000 years ago in Norway. Fundamentally, whalers and capitalists take on a very similar risk profile, which relies on winning big to make up for the low mean internal rate of return.

Whaling net IRR figure

I don’t mean to get too caught up in this tangent comparing VC and whaling. Considering the beginnings of this economic modality in the abstract might seem silly but assessing where venture capital is going requires stepping all the way back to its mercantile origins.

In the 19th and 20th centuries, elements of venture practices can be found in the funding events that occurred during and after the Industrial Revolution. There is no doubt that the U.S. railroad infrastructure, the development of Gulf Oil, and countless other projects required immense capitalization. Investors at the time, like Andrew Mellon, not only invested cash and received equity in return, but also assisted in “nurturing outstanding individuals with promising ideas” [2.] With the financing of firms by sole individuals for equity and the mentorship of founders by the same interested individuals, it’s hard not to see the similarities between then’s “angel investing” and today’s venture capital.

The early real venture firms started materializing in the 1940s. Most famously, the decade saw pioneers like Whitney, of J.H. Whitney and Co; Rockefeller, of Rockefeller Brother’s Fund; Doriot, of American Research and Development (ARD.)

  • Whitney and Co. positioned themselves as “a lender of ‘private adventure capital’” — coining the term for decades to come.
  • ARD pioneered a contradictory model with mixed success: balancing social good while maintaining profitability. This model was perhaps the first precursor to the present near ubiquitous interest of firms in ESG principles.
  • And the Rockefeller’s project was most influential long-term and was later renamed Venrock.

The Modern Age

Soon, the modern limited partnership was being simultaneously pioneered by several firms and the U.S. government was making policy decisions to improve both the demand for venture capital and the supply of investment capital. Greylock famously capitalized on this strategy by generating a strong base of LPs and a record of winning investment decisions in the late 70s and 80s. There’s a lot of complexity in the development of VC during this era, but I have to stay focused on this piece’s purpose.

By the 90s, a more familiar age of VC arrived, fueling the dotcom boom and subsequent bust. Kleiner Perkins, Caufield & Byers, and Bessemer Partners ascended to fame as their leaders implemented unique investment philosophies with impressive success. Again, borrowing from the scholarship of Dr. Nicholas in his book, three distinct investment strategies were developed around this time that have survived until present:

  • Investing in people
  • Investing in profitable markets
  • Investing in new technologies

These firms saw the successful exits of the winners of the dotcom boom and the information and data renaissance that followed.

It’s worth noting that at this time, just like all times preceding it in venture, the capitalists who ascended from associates to partners were most typically stereotype Ivy-league, wealthily born, or otherwise well-connected individuals. Democratization of VC at most levels of analysis was still almost unthinkable. The 2010s, though, saw the proliferation of Micro VCs and even efforts like Venture Forward and Latinx VC that are working on overcoming barriers that have long existed for new players on the field. Technology, too, is driving democratization.

Venture capital is becoming an increasingly global affair, for vaster groups of people — enabled and catalyzed by technology that it helped fund just 30 years ago.

I want to focus on what this means for the future of venture.

II. Towards Democratization

Change on Many Fronts

Previously, I described how the democratization of public offerings has been so impactful for markets and those that invest in them. I feel rather certain that venture can too be meaningfully changed by this type of democratization.

Let me set my boundaries. While it is important to consider what democratization means for VC in terms of gender and race, I’m not going to be explicitly discussing that here. Neither will I be referring specifically to expanding how the venture space is controlled (or by whom.)

What I wish to discuss is the effect of financial technologies on expanding access to venture investment. Since there is no Robinhood for the venture market, one with a decent chunk of change to invest isn’t deciding between putting their money in Greycroft or Sequoia. They likely have no access at all to those funds, or anything like them.

As Goldberg and Walker from Bessemer Venture Partners put it, venture capital is being commoditized. Maybe this a generally better way of describing the change; “democratization” has a connotation that might drive the wrong impression. This is occurring because the market and governmental conditions are right, the culture around investing is rapidly evolving, and, most importantly (in my opinion), the technology is being developed facing every direction: for consumers, for funds, and for companies.

These changes wouldn’t be possible without regulatory changes (in the US, one such change is the erosion of the accredited investor concept) that allow more retail-type or “Robinhood investors” to access private market offerings with a low barrier. On the topic of regulatory change, it is key for regulators to anticipate growing numbers of retail investors and improve transparency by adjusting the disclosure scope for larger investor groups.

The culture around investing has seen its most dramatic shift in the last decade than it has practically ever, too. How long does it take to download Robinhood and invest in a stock? I tried it — under ten minutes. There is a slew of other platforms for the internet-enabled investor; importantly, there’s a lot more than stock offerings. Online communities have sprung up for the purpose of discussing investment (we all know of r/WallStreetBets.)

The final major non-technological factor is the market itself.

Private markets reach a new high, McKinsey & Co
McKinsey private markets figure

As McKinsey reports, private market growth has been demonstrated by nearly 20 percent from 2020 to reach nearly $1.2 trillion; dealmakers deployed $3.5 trillion in 2021. PE continues to outpace both other alternative investments and public markets using several measures after the pandemic-driven lull in fundraising and dealmaking. They note in the report that VC fundraising has been particularly resilient during these times.

Put simply, a growing volume of private market deals and the choice of many firms to stay private instead of seeking to go public will drive interest in private equity offerings.

Technology-Enabled Change

The most pivotal element to investment-access democratization, I posit, is technological change.

Financial technology companies have been innovating in the ways that investors interface with venture capital funds, how VC funds interface with startups, in secondary markets, and everything in between. Dealroom has put together a rather comprehensive database of fintech startups that are leading democratization.

Crowdfunding has been a famous way that retail investors can gain access to private market offerings in recent years. Just the marketplaces of Seedrs and Assetz Capital alone have boasted fundraising totals of almost 100 million dollars, according to this Crunchbase report. These platforms have seen notable exits too, like Crunchbase and OpenSea.

Firms like Crowdcube Cubex and Forge Global have established secondary markets designed for retail investors, the latter of which has seen upwards of $10 billion in trading volume according to Dealroom research. Angel investing and SPV formation, too, have seen their own share of digitization and democratization, in firms like AngelList and a number of others.

Finally, some VC companies are creating end-to-end experiences designed directly for the retail investor, with online platforms and direct investment exposure into impactful venture funds. This technology puts together tax solutions, the nuance of cross-border investments, and the investment desires of individual investors into a fully integrated environment that maximizes the accessibility to the investor. We at VDK are highly interested in this technology.

What am I getting at here? There are technology-enabled companies littered around practically every niche in VC that are lowering the barrier to entry in some of the most historically exclusive investment segments. I’ve not even touched on what’s out there: there are companies assisting in venture fund selection, data verification, fundraising tools, tax solutions, blockchain digital securities, and so much more.

Earlier, I narrowed my focus of this piece to the democratization of access. I think for the argument I am conveying this is the right choice, but that increasing accessibility of VC has significant democratizing impacts downstream. The lower barrier to entry in fund management and SPV creation is directly contributing to progressively more types of people becoming fund managers and angels. Online marketplaces in every venture niche are allowing a wider array of investors (geographically, economically, and ethnically) to get started in investing in venture. In fact, I think that in some ways improving accessibility in venture has greater capability (if indirectly) for diversifying the types of people involved than other efforts designed with specific diversification goals. I am not arguing those efforts are ineffective or unnecessary, I believe the contrary; I just think attacking the problem upstream might just provide more bang-for-your-buck.

Conclusion

You may have read the first and second parts of this essay and been skeptical in identifying the connection, beyond being stories in VC. But I see them as intimately intertwined.

High-risk, high-reward investing is something that is so unique to human culture, emerging from whaling practice thousands of years ago. Now, in the 21st century, it’s simultaneously one of the most interesting and well-performing asset classes.

Furthermore, technology has always been an integral part of venture. Technology and technology-fueled startups are what led to the development of formal venture capital practices, and they’re what continue to transform it to this day.

I’m so excited to watch it continue to transform, and we hope you are too.

For VDK Capital, Sebastian Russo